One year ago, it looked as if the cannabis industry would not be stopped. Canada had just become the first industrialized country in the modern era to legalize recreational marijuana, derivative products were expected to be launched by no later than October 2019, and a number of states in the U.S. were newly legalizing marijuana in some capacity.
And yet, the wheels fell off the wagon. Regulatory and procedural problems in Canada have…
combined to keep legal product from reaching dispensaries. Health Canada has been overwhelmed with cultivation and sales license applications, while certain provinces (ahem, Ontario) have been slow to license physical dispensaries. Meanwhile, high tax rates in U.S. markets have encouraged consumers to stick with considerably cheaper black-market growers.
The end result has been a sea of losses throughout much of the marijuana industry, with Canadian pot stocks being especially susceptible to early-stage red ink.
However, a few growers to our north have managed to buck this trend and generate quarterly profits. Unfortunately, as you’ll see, these profits are nothing more than fool’s gold.
Canadian pot stocks are (legally) fooling you
It’s easy for investors to read a headline number (such as sales, or earnings per share) and take it as fact. But Canadian cannabis stocks are a different breed of company that require more sleuthing from investors to uncover the facts. That’s because publicly traded Canadian cannabis companies report their operating results using International Financial Reporting Standards (IFRS), which has a few marked differences from the generally accepted accounting principles (GAAP) that we’re used to in the United States.
Canadian cannabis stocks are classified as “agricultural companies” under IFRS accounting, and as such are required to make a handful of estimations and reconciliations on their income statements, some of which can seriously alter their operating results.
These are known as “fair-value adjustments.” Canadian marijuana growers are required to:
- Estimate the value of their crops on a quarter-by-quarter basis. How, you ask? Growers offer their best guesses on fair value based on the stage of plant propagation. In other words, flowering cannabis plants are going to be “worth more” than plants that haven’t flowered yet, and growers are required to recognize this on their income statement as an “unrealized change in fair value of biological assets.”
- Reconcile fair-value adjustments on product sold during a given quarter. Not only are Canadian cannabis companies estimating the value of their crops every quarter, but they’re also being required to guess how much it’ll cost to sell those crops, often many months before the sales actually occur. When the sales do occur, these pot growers have to go back and reconcile any differences between the actual costs and the estimate. This is referred to as the “realized fair value adjustments on inventory sold.”
Fair-value adjustments are an above-the-line metric, meaning they either add to or subtract from gross profit before expenses are factored in…
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